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Indo Gulf: Analyst meeting excerpts - Views on News from Equitymaster
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Indo Gulf: Analyst meeting excerpts
Nov 20, 2004

Recent reports suggest that the government is contemplating an increase in natural gas prices by around Rs 350 per TSCM (thousand standard cubic meters). We though it will be relevant for investors to understand the implications of such a move on fertiliser manufacturers like Indo Gulf. We have also incorporated certain key takeaways from the recent analyst meet of the company. Demand and supply…
The fertiliser industry has clocked a 4.9% growth in production and 3.2% growth in sales in 1HFY05. While rainfall this year has been mixed with states like Uttar Pradesh expected to witness a 25% crop loss, urea usage is gaining momentum. Urea consumption, according to Indo Gulf, is expected to touch 19.5 MT (million tonnes) in FY05.

FY06 to turn favorable…
In FY06, the company expects, urea consumption to touch 20.9 MT, an increase of 7%. At 100% capacity utilisation level, the artificial cap on utilisation level as per the fertiliser policy, the industry has the capability to produce 19.5 MT, leaving a shortfall of 1.1 MT. There are various options to meet the shortfall with the government.

  1. To allow domestic players to increase capacity utilisation. There are gas-based urea manufacturers, naphtha-based manufacturers and other fuel based. Gas-based manufacturers are the most cost-efficient among the lot.

  2. Import from the global markets

As per the company, the government has plans to meet the shortfall from the following sources:

  1. 40% from gas-based units, of which Indo-Gulf is a part.

  2. 24% from imports and

  3. 36% from other fuel-based urea manufacturers.

If this is the case, Indo Gulf stands to benefit in a significant manner. Since Indo-Gulf has been unable to increase capacity utilisation above the 100% levels, benefits from economies of scale have not been realized till now. We have not factored in the full benefit of the same in our Indo Gulf’s earnings projections in FY06 owing to lack of clarity.

Imports are costly…
Imports are a costly proposition for the government. As compared to the domestic price of US$ 105 per MT, prices of urea in the global markets are around US$ 277 per tonne. This is likely to increase the subsidy bill of the government. It is a stated policy of the government to remove subsidies in the long-term.

Natural gas price increase…
Recent report suggests that the government has plans to increase natural gas prices (28% of sales in FY04) by around Rs 350 per TSCM. While this is a negative for the industry and Indo Gulf, as a matter of conservatism, we have factored in the possibility of rise in natural gas prices in our estimates. Without going into the complexities, we have increased the cost of natural gas for Indo Gulf by 40% over the next two years. While this is a cause of concern (as cost increases while urea pricing is de-regulated), the downside risk to our recommendation, we believe, is limited.

De-bottlenecking exercise…
The company has submitted a proposal to increase capacity by around 0.3 MT. If the permission is received, the production is likely to commence in FY07. This is a positive. Besides, the natural gas supply agreement with GAIL will ensure stability in supply, which in turn is likely to provide a big kicker for operating margins in FY06.

Our view…
The stock currently trades at Rs 96 implying a price to earnings multiple of 5.8 times our FY06 earnings estimate and at a price to book value multiple of 0.7 times. Considering the upside from the de-bottlenecking exercise and cash per share of Rs 54, we maintain our BUY recommendation on the stock with a long-term perspective.

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